Cash vs Profit & Decoding Cash Flow Statements Revision Notes | GCSE AQA Business

1. The Puzzle: How Can a Business Be Profitable and Still Go Bust?

Here is a scenario that trips up students every year. A bakery sells 500 loaves a day at £3 each. Revenue is strong, costs are covered, and the owner is making a profit on paper. Then one morning, they cannot pay the electricity bill. The lights go out. The business closes. How?

The answer lies in the difference between cash and profit. These two words sound similar, but they measure completely different things. Confusing them is one of the most common — and most costly — mistakes in business.

This lesson will unlock exactly how cash and profit differ, show you how to read and complete a cash flow forecast, and give you the exam technique to turn that understanding into marks.

2. Cash vs Profit: Two Very Different Things

The critical insight is this: timing. A business might sell £50,000 worth of goods in March but not receive payment until May. In the meantime, it still has to pay wages in April. On paper, it is profitable. In reality, it has no cash to pay its staff.

This situation — where a business cannot meet its short-term financial obligations despite being profitable — is called a cash flow problem. It is one of the leading causes of small business failure in the UK.

Think of it like a salary. You might earn £30,000 a year (your 'profit'), but if your landlord wants rent on the 1st and your pay cheque arrives on the 5th, you have a cash flow problem — even though you are not broke overall.

3. Consequences of Cash Flow Problems and the Benefits of Positive Cash Flow

When a business runs out of cash, the consequences can escalate quickly. It cannot pay suppliers, which may lead to stock shortages. It cannot pay wages, which damages staff morale and may trigger legal action. Banks may withdraw credit facilities, making the situation worse.

In the most severe cases, a business with persistent cash flow problems may become insolvent — meaning it legally cannot pay its debts. Even if the business is profitable on paper, insolvency can force it to close. This is why cash flow management is treated as a survival skill, not an optional extra.

On the other side, a business with positive cash flow — where inflows consistently exceed outflows — is in a strong position. It can invest in new equipment, take advantage of bulk-buying discounts, repay loans early, and build a financial buffer against unexpected costs.

• Cannot pay suppliers — risk of losing key supply contracts
• Cannot pay wages — staff may leave or take legal action
• Cannot repay loans — bank may demand immediate repayment
• Forced to take expensive emergency finance (e.g. high-interest overdraft)
• In severe cases, the business may be forced into administration or closure

The list above shows the consequences of cash flow problems. Notice how each consequence leads to another — a chain reaction that can destroy even a profitable business. Examiners love asking you to trace this chain, so practise writing 'This leads to... which causes... resulting in...' chains in your answers.

4. Decoding the Cash Flow Forecast

A cash flow forecast is a month-by-month prediction of the cash a business expects to receive and pay out. It is not a record of what has happened — it is a plan for what the business expects to happen. This makes it an essential planning tool, especially for new businesses or those entering a busy season.

The forecast is built from three key rows: total inflows, total outflows, and net cash flow. Below net cash flow, you will find the opening balance and closing balance. These five elements are the ones AQA expects you to be able to identify, calculate, and interpret.

Now here is where the forecast becomes powerful. Once you know total inflows and total outflows for a month, you can calculate net cash flow. This tells you whether the business gained or lost cash that month.

The net cash flow figure feeds directly into the closing balance. The closing balance tells you how much cash the business has at the end of the month. Crucially, that closing balance then becomes the opening balance for the next month — like a relay baton being passed forward.

Look at the chart above for Priya's Florist. In January, outflows exceed inflows — the business has a negative net cash flow of £1,200. This is common for new businesses or those with high start-up costs in their first month. February recovers strongly, with inflows of £8,500 against outflows of £6,000, giving a positive net cash flow of £2,500.

This kind of chart interpretation is exactly what AQA exam questions ask you to do. You are not expected to memorise figures — you are expected to spot trends, identify problem months, and link them to business decisions. For example, Priya might need an overdraft in January to cover the shortfall, but February's surplus would allow her to repay it.

5. Completing a Cash Flow Forecast: Worked Examples

AQA will give you a partially completed cash flow forecast and ask you to fill in missing figures. The key is knowing which formula to apply and in which order. Let us walk through a full example step by step.

Worked example: Calculating Net Cash Flow and Closing Balance

Mohammed's Gym has the following figures for April. Total inflows: £9,500. Total outflows: £11,200. Opening balance: £3,000. Calculate the net cash flow and closing balance for April.

1. Net Cash Flow = Total Inflows - Total Outflows — Always write the formula first — this earns a method mark even if you make an arithmetic error later.
2. Net Cash Flow = £9,500 - £11,200 — Inflows are £9,500 and outflows are £11,200. Outflows are larger, so we expect a negative result.
3. Net Cash Flow = -£1,700 — £9,500 minus £11,200 = -£1,700. The negative sign means the business spent £1,700 more than it received in April. This is a cash outflow month.
4. Closing Balance = Opening Balance + Net Cash Flow — The opening balance is the cash held at the start of April. We add net cash flow (which is negative here) to find the end position.
5. Closing Balance = £3,000 + (-£1,700) = £3,000 - £1,700 = £1,300 — Adding a negative number is the same as subtracting. Mohammed's Gym ends April with £1,300 in cash. This is positive, so the business can still meet its obligations — but the trend is concerning.
6. Opening balance £3,000 → lost £1,700 → closing balance £1,300. Check: £1,300 + £1,700 = £3,000. Correct. — Always verify by working backwards. If closing balance plus the loss equals the opening balance, your arithmetic is correct.

Answer: Net Cash Flow = -£1,700. Closing Balance = £1,300.

Notice that Mohammed's Gym still has a positive closing balance despite a negative net cash flow month. This is because the opening balance provided a buffer. However, if April's pattern continues into May, the closing balance will fall further — and the business may need to act.

Worked example: Interpreting a Cash Flow Forecast to Make a Business Decision

Aisha runs a garden centre. Her cash flow forecast shows: May closing balance £800, June net cash flow -£2,100. Aisha has a loan repayment of £500 due in July and expects July net cash flow of +£600. Identify whether Aisha faces a cash flow problem and recommend one solution.

1. June closing balance = May closing balance + June net cash flow = £800 + (-£2,100) = £800 - £2,100 = -£1,300 — A negative closing balance means the business has gone into overdraft. Aisha owes the bank £1,300 at the end of June.
2. July opening balance = June closing balance = -£1,300 — The closing balance of one month always becomes the opening balance of the next. Aisha starts July already £1,300 overdrawn.
3. July closing balance = -£1,300 + £600 = -£700 — Even with a positive net cash flow in July, the business is still overdrawn at £700 at the end of July. The £500 loan repayment is already included in the outflows that produced the +£600 net figure, so no further adjustment is needed here.
4. Aisha's business has a negative closing balance in June (-£1,300) and July (-£700). This means the business cannot cover its costs from its own cash reserves. — A negative closing balance is the clearest signal of a cash flow problem. Aisha needs external finance or must reduce outflows urgently.
5. Recommendation: Arrange an overdraft facility with the bank before June. This would cover the -£1,300 shortfall and allow the business to continue trading while July's positive cash flow begins to recover the position. — An overdraft is suitable for short-term, temporary cash flow problems. Since July shows improvement, the problem is likely seasonal rather than structural — making an overdraft more appropriate than a long-term loan.

Answer: Aisha faces a cash flow problem: her closing balance turns negative in June (-£1,300) and remains negative in July (-£700). She should arrange a short-term overdraft to bridge the gap, as July's positive net cash flow suggests the problem is temporary.

6. Exam Technique: Turning Knowledge into Marks

Cash flow questions on AQA papers follow predictable patterns. You will be asked to calculate a missing figure, interpret what the figures mean for the business, or evaluate a solution to a cash flow problem. Each type requires a slightly different approach.

For calculate questions, always write the formula first, then substitute the values, then state the answer with the correct sign (positive or negative). A negative net cash flow is not a mistake — it is a valid answer that needs the minus sign to be correct.

For explain or analyse questions about cash flow problems, use a cause-and-effect chain. Do not stop at identifying the problem — develop it. 'The business has a negative closing balance, which means it cannot pay its suppliers, which may lead to stock shortages, which could reduce sales and worsen the cash position further.'

For evaluate questions about solutions (such as taking out a loan, cutting costs, or chasing debtors), consider both the benefits and the drawbacks. A loan solves the immediate cash problem but increases long-term costs through interest payments. Cutting costs may harm quality or staff morale. The best answers weigh these trade-offs and reach a justified conclusion.